Talking about the dire need of valuable exit in the Indian startup space, Mohan Kumar, partner at Norwest Venture Partners, said that companies which set ‘realistic’ valuations will continue to get funded.
Why are we seeing valuation markdowns?
What happened in the last 12-18 months was purely abnormal. Previously, there was a certain pace at which you would fund a company. For example a Series A company, which is just starting, would be valued at $4 million- $5 million. For Series B, the company had to do earn a certain amount of revenue, show that they have business model that can scale and was then valued at $20 mln- $25 mln.
But over the last one and half years, companies which were in the Series A phase were given cheques worth $40 mln- $50 mln assuming capital will create the winner. What is happening today is just unwinding of what had already taken place, realization that quality of founders and their ability to execute is what it takes to win and not just throwing money. The phenomenon is very similar to that of a stock market bubble, every company irrespective of the fundamentals goes up. The last 18 months saw companies excessively funded for the stage they were in at that point of time and the only goal was to raise more money as quickly as possible.
Impact of markdowns
The valuation markdowns will not impact other startups, until and unless they are realistic about their valuations. They should go back and look at what had happened two years back and set their valuations to the scenario that existed 24 months back. If they remain realistic, they will get funded.
2016 - good year to make investments?
It should be a good year for investments based on two things; companies in India have not yet reset their expectations so far. The market has corrected, but companies continue to use their last round funding as benchmark. According to me, whatever valuation a company had in its last round does not matter and they should be prepared to accept based on their financial performance and Unit economics. Understanding that the market has corrected and whatever valuation they had in their last round of funding was a bubble - this realization should come sooner. It will take at least two quarters for the realization to take place. Following that, the later part of the year should be good for investments.
2016 - Not the best year for exits
While it’s a good year for investments, it’s not the best year for exits. The problem with the Indian startup space is that there are very few good exits. And an exit can happen through an IPO or a M&A. To achieve an IPO you need to scale – both top line and bottom line. None of the big companies have achieved that scale, which rules out the possibility of an IPO. M&A cannot happen at these valuations because there are no buyers at these prices.
Funding stories alone does not tell a good story. If there are a billion dollars being invested, we need to see a billion dollars in exits every year. A good year is when the amount of investments going in is at least equal to the value of exits. A good year for me is measured in terms of profitable exits.
Startups thrive on disruption, which means challenging the existing business model and making it work and ensure it is a scalable company. This can be done across all sectors. Healthcare, retail, manufacturing and education are sectors that are ready for disruption. You need good entrepreneurs to take on complex challenges and make a good company. A herd mentality amongst entrepreneurs is not solving the hard problems that exist in the system. Investors are also part of the problem and encourage such behaviour.
What will NVP look for in entrepreneurs in 2016
At NVP, we will look for entrepreneurs that are solving a real and complex problem. We will check to see if it is an original idea or merely a copy-cat version of another idea. We look for a scalable business models and check whether the company is capable of making at least a $100 million business in the five years and be profitable.
Advice for unicorns this year
My advice to unicorns would be to move away from the past and go back to basics. You need to focus on businesses that are scalable, as well as profitable. Re-engineer the business model, company and reset valuations. You have to do a one-time hard reset. The issue with raising money too fast to become an Unicorn is that expectations of investors goes up, making the founder do things which are not normal and ultimately fail. Do the hard reset quickly and you will have a chance to survive.
What should an entrepreneur keep in mind while pitching an idea to NVP?
We look at the problem the entrepreneur is trying to solve and the uniqueness of the idea. It’s also very important for the entrepreneur to have studied the market he is trying to enter and how his product could help solve the problem that exists in that domain. If the founder is unable to articulate this, we do not take the discussion forward. Secondly, how he can make it big by solving that particular problem. And third factor would be the scalability of the idea.